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TheStreet Open House

Investors Are Betting Too Much on a Bionic ARM

NEW YORK ( TheStreet) -- I recently talked about the disconnect that exists between the share price reaction of Texas Instruments (TXN) and the company's actual performance, which hasn't been particularly impressive in terms of growth. TXN's stock continues to soar despite unimpressive growth.

It seems ARM Holdings (ARMH) now deserves similar consideration -- in the inverse order.

There's no disputing ARM's impressive business model and the company's unparalleled chip performance technology. But there's also no disputing the stock is expensive.

The fact ARM trades at a stout P/E of 82, which is almost five times Qualcomm (QCOM) and three times Broadcom (BRCM), suggests investors are betting heavily on future gains.

So far the wager has been very rewarding. ARM has posted solid growth over the past couple of years. However, increased competition from (among others) a resurgent Intel (INTC) and Nvidia (NVDA) may weigh upon ARM's prospects.

With that in mind, I would adopt cautious optimism about how much should be expected from this company in the long term.

Another Solid Quarter

The company reported revenue of about $263 million, beating expectations handily, growing 26% year over year. When compared to what other chip companies within the sector have done, ARM's performance seems bionic.

ARM posted a 24% increase in license revenue while royalties shot up 33%. Surprisingly, license revenue was down more than 5% sequentially. Even though royalties did well year over year, royalties only grew 1% sequentially. This is an area where the company has consistently posted solid results.

Even though the overall performance of the chip sector has been soft this quarter relative to other quarters, the performance didn't sway that much. Besides, ARM has always outperformed in its license business regardless of what the sector did. Should investors be alarmed? This is one of the chief reasons I caution about taking a position in this stock today.

I'm not suggesting that ARM is not a worthwhile holding. But would you want to take a position now after a 5% sequential decline in license revenue without knowing yo what it may lead?

The good news is ARM was able to offset some of that weakness in service and development systems revenue, which posted growth of 11% year over year and 7% sequentially.

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